Analyst Picks and Pans: Alcoa, PepsiCo, Discover

Stifel Nicolaus & Co. analyst Mark Swartzberg said on June 29 that PepsiCo Inc. and its largest bottler, Pepsi Bottling Group Inc., are poised to grow even if PepsiCo fails in its bid to take over its two biggest bottlers.

In addition to upgrading both stocks on June 29, Swartzberg initial 12-month target share prices for the companies. He told clients in a June 29 note he set a 12-month target for shares of PepsiCo of $64, while he expects Pepsi Bottling's shares to reach $37.

PepsiCo, maker of drinks like Gatorade and Pepsi colas, has been trying to buy Pepsi Bottling Group and another bottler, PepsiAmericas Inc., saying owning its bottlers would help it cut costs and operate more efficiently. The company first offered $6 billion for the two in April, but both bottling companies rejected the deal, saying it undervalued them. Analysts have speculated that PepsiCo, which also owns the Frito-Lay snacks business, must raise its offer to get the deal through.

Swartzberg told clients that his upgrade of PepsiCo is made whether or not the deal goes through, since he believes there's attractive risk and reward to the company.

But he also said: "We also believe the risk/reward is more attractive if the bottler transactions are completed and consider this most likely."

In either case, he said, he expects earnings for PepsiCo to grow due to improving volume growth in the Frito-Lay business, PepsiCo's largest, dropping commodity costs and other improving trends. He said earnings acceleration would be greater, though, with the bottlers than without.

For Pepsi Bottling Group, Swartzberg said the Somers, N.Y.-based company's current share price does not reflect fair value. He also believes, that "PepsiCo lacks the leverage, in spite of their PR, to insist on something at or below PBG's current market price."

He said he believes Pepsi Bottling's board will keep waiting for a higher offer from PepsiCo. Its initial offer was valued at about $29.50 a share, and he notes shares are trading higher than that now since the market expects an increased bid.

Discover Financial Services (DFS)

Keefe, Bruyette & Woods upgrades to outperform from market perform

In addition to upgrading the shares on June 29, Keefe, Bruyette & Woods analyst Sanjay Sakhrani increased his price target for Discover to $14 from $11.

In a research note, Sakhrani said if the company were to simply go into runoff -- a situation where it books no new business and lets outstanding balances be paid off -- and it liquidated its other divisions, its value would be more than its current share price.

Though credit quality is likely to continue to deteriorate into 2010, Sakhrani said those risks have been factored into his earnings estimates. Also, the credit-card lender's portfolio has less exposure to some of the hardest hit areas of the country, such as California and Florida. That means Discover's credit performance is likely to be better than other lenders.

Its portfolio is also a bit older and had less growth during recent years, Sakhrani noted. The worst-performing loans across nearly all loan types were those originated during the past couple of years leading up to the recession.

Sakhrani also noted the strength of Discover's credit card and debit-card networks, which would be attractive assets to other financial institutions should the lender consider any deals when the economy starts to rebound. The company's networks are probably worth about a combined $1.5 billion, Sakhrani wrote in the note.